It continues to perplex me why there should be a distinction between an emergency fund and your general savings. There is an emergency fund fallacy that needs to be rectified.
If you have $100,000 in the bank, what is the difference between calling it $100,000 in savings, and splicing the funds into $10,000 emergency money and $90,000 savings?
The answer lies in the fact that people who need to create an emergency fund likely always have “emergencies” and are weak with their spending and savings!
An Emergency Fund Is All The Same Money
Let's say your name is Mr. Benjamin aka a $100 dollar bill. You're relaxing with your fellow Benjamins in the bank, hopefully earning at least a 2.5% interest rate using the “DVD Method To CD Investing” and having a grand old yield maximizing time.
A Benjamin's purpose is to provide a solid source of liquidity and risk free interest income for the owner upon his or her retirement. Some Benjamins are lucky. Their owners don't discriminate between one bill or another. They treat each bill with vital respect i.e. they don't touch it!
Some owners are just nutty, always disturbing their party and separating one Benjamin from another. “Listen up Benjamins! 100 of you are to relocate to this side of the tracks, and the other 900 Benjamins get to kick back and relax!“
Be Careful Of The Emergency Fund Fallacy
Don't use a crutch if you can walk just fine.
As soon as you start identifying some of your savings as emergency fund money, that portion becomes “at risk.” Your emergency fund becomes a slush fund that tempts you to spend because you don't have the discipline enough to lock away your retirement money.
You bring your savings to the front lines, allowing you to justify your desires because you've earmarked other monies for retirement.
Having a large emergency fund is a crutch. You start thinking in emergency fund type increments. That's a lovely iPad my emergency fund can cover no problem!
Or, let's buy a brand new car and take out a loan since our emergency fund can take care of the payments! 1/10th rule for car buying? What's that! The list of stuff you start wanting gets longer and longer until you no longer can control your temptation.
It's OK To Use Your Emergency Fund
Worse yet, some of you might treat your emergency fund money like gold and never spend it! What does that mean? It gives you a green light to spend all your other money at will because you feel artificially complacent that no matter what, you'll still have your piddily emergency fund to depend on.
This could be the more dangerous result, since an emergency fund is generally only a small fraction of your overall savings.
If you exhaust your emergency fund, you can always sell some stock to pay for true emergencies. Just do your best to replenish your stock holdings in the near future.
Look At Your Finances More Holistically
As soon as you identify the weakness of the emergency fund concept, you'll realize that you're just making excuses for your spending and savings habits. Instead of creating an emergency fund, go broke to win big and lock your money away.
Sure, make sure you have enough banking relationships to keep your funds safe and accessible. You certainly don't want to be caught in a bank run and have your funds get locked up.
However, up to $250,000 of your cash per ownership is FDIC-insured anyway, so I wouldn't worry too much.
If you have to create an emergency fund, you are scraping at the bottom of the barrel with regards to your personal finances. Don't get me wrong. Having an emergency fund equal to six months of living expenses is fine. But any more is probably too much.
Do you think multi-millionaires have emergency funds? Nope. They have tax efficient muni bonds, private equity investments, Treasury bills, they can easily liquify if needed. Stop thinking so small and start thinking bigger, holistically if you will!
A dollar here is the same dollar there. Focus on fixing what's most important, your money habits.
Related: The Need For Liquidity Is Overrated
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I handle the problem by having a depreciation account. The account does what the name suggests. For larger items that you have to replace every 8 or 10 years or so i create a depreciation account. I break down how much it costs me monthly during the expected time of use. If I were to buy a car for say 15.000$ and expect to drive it for the next 8 years that works out to be 156$ a month, so i’d add 156$ monthly to this account. This money I do not count as part of my net worth. Nor is it part of what I call savings, nor is it the emergency fund. Same goes btw for maintenance on your house. There is a reason why the government allows a landlord to take a depreciation charge, because if you do not do enough maintenance it will eventually break down.
I also do have a real emergency fund and so far I have never touched it. It is for real emergencies outside of everything you might reasonably expect and which for some odd reason you are not insured against. So far I have no idea what this could possibly be. Maybe medical bills of some rare illness that for some reason is not covered by your health insurance or something like that.
Both accounts don’t are real accounts btw, they simply exist as spreadsheets. When I do financial planning I simply deduct both funds from net worth and liquidity available when looking at my bank account.
I found this post by googling “savings vs. EFs.”
A few years ago, I and a dozen or so of my colleagues were laid off. All of a sudden I’m paying $700/month for COBRA along with my regular expenses with only a pittance of UI income. A month later, my upstairs neighbor had a fire. Due to the water and smoke damage, the city issued a vacate order on the building. I had no job and nowhere to live. Insurance paid $3K for relocation expenses. That is not much in this part of the world. Had I not had an EF…I don’t even want to think about it.
Sorry to hear about the layoff. Healthcare costs are a KILLER. I’ve being paying ~$700/adult since I left my day job in 2012 as well.
I’m glad you had an EF and are OK. Now use this moment to SAVE LIKE CRAZY when you get a new job. You will get through this.
Related: How Much Should I Pay For Healthcare?
Brilliant post. It’s causing me to re-think my mindset towards the “emergency fund” #’s in my personal finance spreadsheet…
(I know this is an older post but I just recently discovered your site.)
Whether you choose to call it an emergency fund, a sanity saver, or a preventative tool to keep you from doing something stupid in a moment of crisis, everyone needs to have enough funds available to keep them going if it really hits the fan. TRUE emergencies are often compound events. An acquaintance’s house burned to the ground in a massive wildfire, and his place of employment came within a block of burning down too. Imagine losing your home and your source of income in one afternoon. When a huge disaster hits, you may take multiple hits (loss of life leaving behind dependents, loss of family, loss of home, loss of employment) all at the same time. That is totally different from the “life happens” events that happen one at a time: a car accident, a storm that leaves $30K in damage in its wake, a temporary layoff, or even a cancer diagnosis. The one at a time events you can roll with. The disaster with multiple hits simultaneously will knock even the most prepared and optimistic person off their feet.
Thanks for sharing your thoughts. How did you find this post?
I came across the “Average Net Worth For The Above Average Couple” and liked the way you think so started scrolling through your older entries. Sorry my first post wasn’t about one of the many areas where I do agree with you.
Hi Financial Samurai. I first want to say that I recently discovered your blog (about a week ago) and find myself sifting through pages of this for hours at a time – your stuff is great.
I graduated last year in 2014 and have been working at my first job at an insurance company in the Bay Area for a little over half a year. Once I started bringing in “real” paychecks for the first time in my life everyone close to me (parents, friends, etc) and just about anyone else’s personal finance opinion will tell you that the first thing you need to do is BUILD AN EMERGENCY FUND. I was curious what your take was on the subject because I’ve already grown to really like your content and respect your opinion…which led me to this article.
I fully understand and agree with your argument but there’s no denying the fact everyone must have a certain level of liquid assets for that “rainy day” that many have mentioned in previous comments.
It seems to me that the way to look at this is the way that all insurance companies view and handle it. Insurance companies are in the business of saving for a rainy day, particularly YOUR (the customer’s) rainy day. They are also in the business of making money – if they aren’t you probably don’t want their insurance. Insurance companies are unique in that they are one of the few services that gets your money before you get what you paid for (and hopefully you never will!) so they naturally sit on a giant pile of cash. Obviously they would like to invest it and put it to work. However, it is good practice (and all states have certain requirements) to have a certain level of reserves in order to pay out claims as people crash their cars, there are earthquakes, etc.
While the personal finance/emergency fund side of it is far less complex the theoretical concept is the same – we all want to put as much of our hard-earned cash to work as possible but retain enough liquidity to cover unexpected expenses in the short-term. It’s less about segregating your Benjamins and more about making sure there are just enough of them that are just close enough by to cover your expense fluctuations and/or unexpected events.
I think having an emergency fund is a great first step (a crutch). As you expressed, for those of us that have advanced, it’s best to not consider it a separate fund, but one large amount of savings that should be reinvested.
Sounds good. How did you find this post btw? I wrote it a couple years ago. Thanks
I second your opinions here. The key to amassing wealth is not setting aside “play money” and “safe money”, but to instead treat all your money with the same respect.
What if there is no emergency fund but have mutual funds and some properties? Would that be fine?
I usually have most of my savings invested. I’ve kept my cash inflow liquid this year though because CD rates are crap right now. And luckily I’m quite disciplined and not tempted to spend it.
Even though CDs are crap, if you don’t need the money, you are better locking it up in 2.5% money than 0.3% money!
Ha ha. This is what I love about you, Sam. Thinking out loud. I used to have a knee jerk reaction to posts like this. But once I really think about it, it starts to make sense. I was divying up my savings the other day and thought, “what the heck, savings is savings. Just save the damn $$.” And then I relaxed and haven’t though about it since.
Thanks for the thought provoking posts :-)
Save the damn money indeed! People need to graduate already from such basic personal finance thinking.
I don’t discriminate between my dollars – aside from retirement savings and investing, I just have one big lump sum sitting in my savings account. I’ve never had something that I specifically call out and size as an emergency fund, my savings account has just always had over a year’s worth of living expenses in it.
As I pay for business school though that savings account is going to be cleared out and I’m wondering how much of a margin I need to keep for safety – a true emergency fund I suppose.
Either way, I think the commentors are right that the bigger problem is with the people, not the technique in and of itself.
The people who are what breed this technique of thinking. It’s fine for the absolute basics, but if anybody plans on gaining true wealth, they’ve got to get out of this mindset.
I enjoy the broke feeling. It’s thrilling so dot worry!
I have to whole-heartedly disagree with other posters’ assessments of how people use emergency funds as crutches and excuses to buy. Anyone who does that or thinks of their EF as a crutch is just fiscally irresponsible, and they’d spend their money irresponsibly no matter what they called call the account.
In my opinion, EF’s – when used properly – are more about making sure you can keep yourself afloat (and out of debt and with a roof over your head) during an extended unplanned “fiscal outage.” For me and my husband, we’ve got an EF that covers a full 6 months of expenses, and if we were to only lose one of our incomes, we’re covered for well over a year. My hubby works for a state uni in IL, and the state hasn’t been as good with their finances…knowing we have that EF set up gives me such peace of mind. Given that my husband is a professor in the sciences, and given that getting a prof position is a process that can take anywhere from 6-12+ months (academia moves SLOWLY), it’s imperative that we’re ready for that.
Like a few other folks who have commented here, we have multiple savings accounts earmarked for different purposes. I set up a house fund (home repairs & savings for next purchase), car fund, tuition fund, fun fund, gift fund (x-mas & birthdays), and a newly created slush fund. That slush fund is going to act as our short term EF and a temporary holding spot for additional funds that can be allocated elsewhere (i.e., additional investments, extra mortgage/car payments) – this will help us get better returns in the long run than simply letting the money sit in checking or savings.
Now I’m not trying to say that everyone needs to set up umpteen savings accounts for every category imaginable. But for me, it channels my obsessive compulsive tendencies into something that is positive, gives me & husband peace of mind, and allows me to do actually feel okay about spending money on “fun things” while not taking us off track of reaching our financial goals. Call your EF whatever you want – I just highly recommending having some sort of safety net so that an interruption in cash-flow doesn’t send you spiraling into debt.
Setting up all sorts of emergency funds for this, this, that, and that is a bit too neurotic for me. One forgets to see the bigger picture. If you micromanage THAT much, you will surely be stressed out and start becoming a financial cripple.
“Making sure you keep yourself afloat” is exactly the mindset I want people to get out of. If you keep thinking in emergency fund terms, you will never be able to truly work towards financial freedom.
The importance of subdividing your cash assets into different categories, such as emergency funds, car replacement funds, income replacement funds, etc, is that it gives you a better sense of what you can afford.
I have savings categories in my budget for a number of “lumpy” expenses such as car repair, car replacement, clothing expenditures, and medical expenses/copays.
I have an emergency fund that is about 2K dollars–for something completely unexpected that needs to be paid for. What would this expense be? I have no idea. Almost every other expense I can think of is accounted for and, to some degree, saved for, in my budget so it would have to be something unusual.
Right after the emergency fund I have money put aside for replacing my everyday living expenses in the event of an interruption to my income.
Right above that, I have savings for a house and savings for retirement.
By having the whole sum divided up, and referring to the division of the funds as listed in my budget, it allows me to see what I can easily afford in any one category and avoids me dipping into funds that are reserved for emergencies, medical expenses, car repair, car replacement, or what have you, when I get the urge for that new Ipod or whatever.
I carry these figures with me in my wallet so I can refer to them if necessary when I am out of the house.
Sounds good Steve, and that makes a lot of sense. My suggestion is basically to encourage people to move BEYOND just thinking about an EF as it turns into a crutch. Once you get out of micromanaging your finances and shooting for true wealth creation, things really start happening.
Interesting perspective, this is something I have thought about often. Like you, I personally do not make a distinction between my EF and other long term savings. It is liquid enough that I can get to it if I need it, and in the meantime it is earning more than if it were sitting in a bank savings or money market account. That said, I do think that personal finance is personal and some people might benefit more from drawing that distinction, especially if it can help break the debt cycle.
Creating an EF doesn’t break the debt cycle. Using all one’s money to pay down debt, including the EF money breaks the debt cycle!
I do not have an emergency savings, just a savings account. The one account gets used for a multitude of things but mostly it doesn’t get used at all. I just keep adding to it. It may turn into an emergency fund if I’m ever unemployed. Mostly the term emergency fund is used to try to convince people to start saving instead of living paycheck to paycheck. Especially a young person just starting out, once you get them to start saving, not only will they be prepared for emergencies that come along, like a car repair bill, but they start getting it and realize that it is in their best interest to save for the long-term.
I used to have this emergency fund until I realized having this kind of fund always end up either on emergency situations or emergency purchases. There is not much difference with emergency fund and my savings since if you ran out of emergency fund; your savings will be pulled out. Now, the part of my money that I don’t want to be used is invested in a time deposit account and not in savings account. This is one way keeping myself out of the fund.
Savings accounts are HEAVEN for banks who pay under 0.5%. People gotta get smart and stop lending banks free money.
I don’t have a designated emergency fund account, but I do like to keep enough cash on hand in my savings account for 3 months living expenses (I am closer to two right now). I can always sell a stock if I am low as well.
I don’t think saving for emergencies is a fallacy, but it is important to have the money available. I think we think alike on this one.
.-= Eric´s last blog ..Ask The Readers: Student Loan or Savings =-.
I never really bought into the whole fallacy of emergency funding. Such dormant funding… That could be spun into the asset column, or worse still, get chiseled into via inflation! Oi!
Given that I’m an avid gold and silver trader in my spare time, it always seemed more sensible to put my emergency funds in that, while enjoying the appreciation and hedge against inflation today. Enough to get me out of a jam, at the least. The rest I’d rather have backed into tax-haven dividend stocks.
.-= Aury (Thunderdrake)´s last blog ..3 more things you can put in your hoard =-.
Aury, with gold at $1,600/oz, I hope you have made a killing in the past 13 months!
Those who use an emergency fund like you describe (to buy an iPad for example) don’t really have an emergency fund. They have a “I can spend X amount” fund.
The point of the emergency fund is that it’s only to be touched in a true emergency. Using it for anything else defeats the point. Separating the money, I believe, helps to create a mental block that forces you to ask yourself “Is this a real emergency?”
I never heard of emergency funds before I started reading blogs. I suppose E funds are primarily intended for people who are in debt and need a buffer between them and their debt obligations if they lose their jobs.
For those with savings and no debt, they might as well just use a credit card for their emergencies and then liquidate some savings to pay it off. That’s what I do. No real reason to have cash sitting idle unless it absolutely has to, say, if markets are overvalued.
.-= Early Retirement Extreme´s last blog ..The value of reviewing bad books =-.
I see savings and emergency fund as two completely different things.
As a budding triathlete, I’d like a road bike — my mountain bike is a drag. I would buy a bike out of savings. I would not buy a bike out of the emergency fund.
When, at 31, I was diagnosed with cancer and missed 6 months of work, my husband and I were grateful to have an emergency fund because ends weren’t meeting.
Hi H Lee – Thanks for your example. I hope your cancer is in remission and you are doing fine!
Remission for 2.5 years :). Someday, we will have enough money saved or have a strong enough cash flow not to be concerned with an EF separate from savings, but when your gross income for 2 is $80K/ year, $100K in savings takes a long time.
$100,000 was just a nice round number to use for illustrative purposes. Even $10,000, I’d treat the same.
Congrats on remission! That’s great!
$100,000 was just a nice round number to use for illustrative purposes. Even $10,000, I’d treat the same.
Congrats on remission! That’s great!
Hmmmm…. Interesting thought. I don’t distinguish between the amount I regard as “emergency fund” and all the rest of my savings. However, I do keep the emergency fund–about enough to live on for a year–in safe, liquid form. To wit, in the bank.
I don’t regard it as something that I can just spend, any more than one would just spend one’s retirement savings. The fact that it’s not in the stock market and so pulling it out isn’t a taxable event doesn’t make it any less a form of long-term savings. I see it as de facto disability insurance, should I be injured or fall ill and find myself unable to continue even the measly part-time jobs I’m taking in layoff-induced early retirement. Given the current volatility in the market, I would not feel safe investing this money in higher-earning instruments. They’re likely to be bigger-losing instruments.
On the other hand, I do have a small fund of what I call “diddle-it-away savings,” to which I contribute each month from cash flow. This is what I use to cover things like clothes, the $700 pair of glasses I just had to buy, the $1,200 car maintenance bill, and the $450 bill the air-conditioning guy surprised me with last month.
.-= Funny about Money´s last blog ..DIY Veterinary: The dog-proof hot-spot bandage =-.
Most of my savings is all locked up. I keep some savings liquid which could be the closest to an emergency fund but I’ve never had to spend it. The way the markets have been acting lately, I’m definitely going to keep up my savings trend going.
Really well said Live Cheap. If you have so much money saved, you don’t think in emergency terms. Yet, if you think in emergency terms, it’s hard to break out of that thought process and save tons! Catch 22!
I used $100,000 in savings as an example for illustrative and easy math purposes.
Some kids never stop sucking their thumbs and biting their blankies, even in adulthood though. Best to ween em off!
Thanks for your thoughts.
The purpose of an emergency fund is to help people separate qualified and non-qualified monies. People need to maximize qualified monies and invest them into as risky assets as is consistent with their individual risk tolerances and is consistent with appropriate diversification principles. I see young people talking about early retirement and they invest in CDs with taxable money, earn miniscule rates and then pay part of that to Uncle Sam. I don’t get it!
Too many people get stuck into raiding their 401(k) or IRA because they haven’t set aside enough for the unexpected expenses that inevitably come along.
.-= DIY Investor´s last blog ..Benchmarks revisited =-.